Who Else Wants Ex-U.S. ETFs?

After decades of flying high and shrugging off crises around the world, U.S. equity markets have fallen on some tough times. The epicenter of the mortgage crisis that evolved into a global recession has scared away many investors away from the U.S. markets, afraid that the worst isyettocome and that the “glory days” of America have passed. Investor reluctance to jump back into the U.S. markets is perhaps best evidenced by the increase in popularity of “ex-U.S.” ETFs, funds that offer exposure to a well-diversified basket of global securities but avoid any investments in the States. Over the last year, many of these funds have experienced strong fund inflows, and have significantly outperformed major U.S. benchmarks.

As unemployment remains high, banks continue to close, credit markets are yet to thaw, and the future of the dollar as the world’s reserve currency sits in serious jeopardy, many investors, both in the U.S. and abroad, are reducing their exposure to American equities. Among the most popular ex-U.S. ETFs on the market:

Vanguard FTSE All World Ex-U.S. (VEU): VEU is an extremely well-diversified fund, with more than 2,100 holdings. Europe (47.2%), Pacific (23.9%), and Emerging Markets (22.7%) account for the largest holdings of this ETF. With an expense ratio of 0.25%, VEU is one of the cheapest ex-U.S. ETFs available.

State Street SPDR MSCI ACWI ex-U.S. ETF (CWI): CWI also offers exposure to both developed and emerging economies, with Japan (16.9%), the U.K. (15.0%), and Canada (7.8%) accounting for the largest country allocations.

PowerShares FTSE RAFI Developed Markets ex-U.S. Portfolio (PXF): PXF maintains significant exposure to the financials sector, with more than 35% of its investments allocated here. This ETF selects large cap equities from developed markets based on four fundamental measures of size: book value, income, sales, and dividends.

State Street SPDR S&P World ex-U.S. ETF (GWL): GWL is quite similar to State Street’s other ex-U.S. equity ETF, with Japan, the U.K., France, and Canada accounting for major holdings. GWL is also well-diversified across industries, with financials(24.2%) and industrials (13.8%) given the largest weightings.

Vanguard FTSE All World ex-U.S. Small Cap ETF (VSS): VSS tracks an index comprised of about 3,300 stocks in more than 45 countries. The median market cap of funds included in the index is only $201 million (as of February), indicating the ETF is dominated by small cap companies.

iShares FTSE EPRA/NAREIT Global Real Estate ex-U.S. Fund (IFGL): This ETF tracks an index that measures performance of companies engaged in the ownership of real estate in the Canadian, European, and Asian markets. Despite continued weakness in the U.S. real estate market, many international ETFs, including IFGL, have flourished this year.

iShares S&P World ex-U.S. Property Fund (WPS): WPS maintains many of the same holdings as IFGL, offering significant exposure to real estate markets in Japan and Hong Kong. China accounts for just over 5% of WPS holdings.

Despite the abundance of options for investors looking for global equities devoid of U.S. exposure, nearly all of these ETFs have performed well in 2009, with most of them attracting positive cash flows and all of them in the black year-to-date.

By comparison, SPY (which tracks the S&P 500) and IWV (Russell 3000) have returned 3.4% and 4.4% in 2009. VNQ, a broad-based U.S. real estate ETF, is down 14.6% on the year. The dismal returns of U.S. funds relative to their global peers have a few important implications: 1) the benefits of diversification, which were much maligned during the broad global downturn, still have some merit, and 2) the U.S. recovery process is lagging far behind the rest of the world. While exposure to U.S. equity, fixed income, and real estate markets is still an important part of any well-diversified portfolio, it’s clear that investors are moving towards larger allocations for international funds in the current economic environment.

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